There's an oddity in Australia's economy that could keep interest rates on hold for some time yet

As a major producer, Australia’s economic fortunes are often dictated by movements in global commodity prices.

When they’re strong, so is the economy – usually. And, when weak, Australia often struggles.

In the past 18 months, commodity prices have ripped higher, propelled by a combination of a strengthening global economy, strong demand from China (the world’s largest commodity consumer), along with a weaker US dollar.

As Gareth Aird, senior economist at the Commonwealth Bank, points out, it’s delivered an economic windfall, boosting nominal GDP, the broadest measure of change in national income in Australia.

“In Australia, commodity prices play a big role in nominal GDP moves,” he wrote in a note released earlier this week.

“The latest national accounts put nominal GDP growth at a strong 7.7% per annum in the first quarter of 2017. This is the highest rate of growth in national income since the GFC.”

This chart from the Commonwealth Bank shows the relationship between changes in nominal GDP and Australian terms of trade, something that is simply derived by dividing the value of exports by imports.

Source: Commonwealth Bank

As opposed to real GDP which measures output in volumes, nominal GDP measures changes in both volumes and prices over a specific period.

So thanks to booming commodity prices, Australia’s national income has surged over the past year, helping to boost corporate profits and government revenues.

However, as opposed to past episodes when national income has risen this quickly, there’s been something of an anomaly on this occasion – it hasn’t flowed through to the household sector through higher wages, as it usually would.

“The primary and most direct mechanism for higher national income growth to flow through to the household sector is via wages growth,” Aird says.

“Historically, changes in commodity prices have been positively correlated with wages growth in Australia. But there has been no lift in wages growth despite the lift in nominal GDP growth.”

Aird says that there are a few reasons why there’s been no transmission from higher commodity prices to wage growth on this occasion.

“In our view the single biggest factor that has pushed down on wages growth is elevated labour market slack,” he says.

“In addition, the recent increase in commodity prices has not and will not generate a lift in investment like in previous cycles. Therefore it won’t materially contribute to labour market tightening like the prior commodity price booms.”

“Over the past year, employee salaries and wages growth has been incredibly weak. In contrast, the big rise in national income has been captured through a lift in company profits and taxes,” he says.

Source: Commonwealth Bank

It’s little wonder why such a divergence has been seen in recent readings on Australian business and consumer confidence.

Business conditions have been soaring while, in many instances, wage growth for workers has been going backwards.

According to the ABS, growth in hourly pay rates in Australia’s private sector hit a record-low rate of 1.78% in the year to June. With inflation growing by 1.9% over the same period, it meant that real wages declined, continuing the pattern seen in the first three months of the year.

In the 12 months to May, they increased by a paltry 0.8%, again well below the pace of inflation. That means that for the vast bulk of Australian workers, real wages went backwards over the past year.

With commodity prices likely to fall in the period ahead, Aird says that Australia’s terms-of-trade look set to decline in the coming quarters, weighing on nominal GDP and, as a consequence, government finances and corporate profits.

“We expect the terms-of-trade to trend lower over the next few years, but to remain above its trough in early 2016,” says Aird.

“As a result, our forecast profile has annual nominal GDP growth easing to a low of 2.1% in early 2018 despite a lift in real GDP growth. This means that the Federal Budget will remain under pressure because growth in tax receipts will slow.”

Source: Commonwealth Bank

And, with that unlikely to help boost wage pressures, Aird says that will keep any talk of a rate hike from the Reserve Bank of Australia for some time yet.

“Despite a solid lift in national income over the past year there is still plenty of spare capacity in the economy which will continue to weigh on wages growth and core inflation,” he says.

“The labour market is tightening, but from our vantage point underlying wages growth will remain soft for some time. In addition, the higher AUD is acting as a disinflationary force and will weigh on nominal GDP growth over the period ahead.

“As such, we think that policy is on hold until core inflation is on a sustained uptrend which we suspect won’t be until late 2018.”

Australia’s June quarter GDP report will be released on Wednesday, September 6.

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